Free Cash Flow Valuation

Growth Rate of Revenues 

The growth rate of revenues used to calculate GAP Inc. stock price was based in two key assumptions:

The first is the initial growth rate for the first four years 2024 to 2028. This growth rate was determined by taking the average sales forecast from Value Line and FactSet as seen in figure 3. It is important to note that the forecast shows a decrease in revenue in 2024 from 2023. Though after 2024 it increases each year after

The second assumptions talk about the long-term growth rate. Most companies' mature growth rates (or long-term growth rate) are between 1-5%. GAP Inc. long term growth rate is estimated to be at around 3% and maxing out at 4% over the next 10 years. Figure 2 shows this assumption. This is because of the high growth opportunity in the retail industry market. It is also because of the expected increase in the clothing market. 

Cost of Goods Sold - Percentage of Revenues

The cost of goods sold as a percent of revenue has one main assumption. It was taken as an average from the last two years. The general vertical analysis from 2019 to 2023 had a higher cost of goods and fluctuated over the years. The COGS levels out in 2022 and 2023. this can be seen in figure 4. So the average of the past two years was used to determine the percent of COGS out of revenue. The COGS estimates from Value Line and FactSet were not used as they were a lot higher than the last few years for GAP Inc. . Value Line had around 59 for COGS as a percent of revenue. This is a pretty fair estimate since 2 out of the past 5 years went over the estimate of 59%. This can be seen in figure 5. The past two year average was used for each of the next 10 years as it can be seen the leveling of the COGS in 2022 and 2023. GAP Inc. is currently experimenting with increasing inventory to be able to meet any surge in demand. Which means they are trying to be financially responsible with the cost of goods.

Selling, General, and Administrative Expenses - Percentage of Revenues

Selling, general, and administrative (SG&A) expenses as a percent of revenue were assumed to be an average of the last two years. SG&A were very high for the past five years for GAP Inc and has continued to increase as well as the averages that are shown below in Figure 6. Over the last two years they have increased so it makes sense to use the higher values overall.

Changing in NOA - Percentage of Revenues

Net operating Assets (NOA) represent the assets associated with the core operations of the busines. Any change in NOA means an investment in these core operations. A negative change in NOA as a % of sales means that the company is investing in operating assets. A positive NOA as a % of sales may mean that the company is not investing in operating assets but rather liquidating them, As shown in the figure 7 below NOA has increased significantly the decreased in the first model but only increased significantly in the second model. The % for NOA was the average of both models last two years averages. From 2019 to 2021 the NOA model numbers were dramatically different then 2022-2023. These would skew the data to have a much smaller. 2019 to 2021 were considered outliers and not included in the average date for the last three years and last five years.

Operating Income Calculations 

The next set of assumptions are associated with calculating operating income which is necessary to calculate free cash flows. Each major expense categories were estimated by using GAP Inc. income statement.

1. Cost of Goods sold: calculated as a percent of revenue as explained above.

2. Selling, General, and administrative expenses: calculated as a percentage of revenue as explained above.

3. Research and Development expenses: this was calculated as the average of the last the last two years from GAP Inc. income statement.  From 2020-2022 R&D fluctuated up and down but has stayed consistent but then stayed consistent for beginning and end of 2023.  Over the next 10 years R&D Expenses has head of steady increase by either $1 or $2 million leading up to 2034.

Free Cash Flow and Stock Price Calculations

In figure 8 shows how the use of the estimates below calculates free cash flows for each year and each one is discounted by the WACC in post 7. The present value of the future cash flows I then entered into the table as the enterprise value of the firm which is then used to calculate the firm's stock price. As seen below the enterprise value is much higher compared to the excess assets and value of the debt.  This overall makes the stock valuation higher.

Stock Price Justification

Based on the assumptions made above, this is a strong estimate of GAP Inc. stock price given all the current available information.  GAP Inc. should mature over the next few decades and stay consistent as well as the rest of the retail clothing industry. I do not see any intentions of major declines as long as they stay up to date with other major trends that are going on relative to their industry. The FCF model shows that GAP Inc. stock price is right around its current value and has no intentions of major increases or decreases over the next decade.

Link to Excel: The Gap Inc NYSE GPS Financials MASTER.xlsx